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Commodities: This Time is Different

January 29, 2011 10:13 amJanuary 29, 2011 10:13 am

I’ve been getting a fair bit of correspondence insisting that political unrest, in the Arab world and elsewhere, is being caused by … Ben Bernanke. You see, quantitative easing is responsible for rising
food prices, which leads to riots, which — OK, there are a lot of broken links in that chain. But it surely is time to take a look at food prices and commodity prices more broadly.

During the last commodity price spike, less than three years ago, many people laid the blame at the feet of speculators. I never accepted that as the prime cause, mainly because so many of the speculation-did-it people
seemed confused about the difference between buying a futures contract and actually hoarding physical stocks; as a very useful analysis by Sanders and Irwin (pdf) puts it,

Index fund buying is no more “new demand” than the corresponding selling is “new supply.”

True, high futures prices can provide an incentive to accumulate physical stocks. But during the 2007-2008 price surge there was little evidence of such accumulation.

What about this time?

I find it illuminating to take the IMF commodity data and rank commodities by the percentage price increase during 2010:

IMF

Up at the top are cotton and iron ore. What’s going on up there?

First and foremost, China: it’s clear from news coverage that Chinese demand is driving the markets. As I and others have been pointing out, we’ve got a bifurcated world right now, with advanced economies
still depressed but emerging economies in an inflationary boom; commodity prices are reflecting the boom part of the picture.

But Chinese demand isn’t just a matter of fundamentals: all the evidence suggests that there’s a lot of physical hoarding going on. Chinese farmers are apparently hoarding lots of cotton,
while China is holding record stockpiles of iron ore.

So the case for a speculative component is a lot stronger this time around. But — and this is important — the speculation is not being driven by financialization, by all those index fund investors
going long. Cotton hoarding seems to be taking place at the level of individual Chinese farmers and factories, with no indication that they’re being influenced by the futures market. And iron ore hasn’t
been available for futures-market speculation: the first futures markets there came into existence just a few days ago.

For at least some commodities, then, we’re seeing a real demand boom, which may be getting reinforcement from speculative hoarding, but with this speculation taking old-fashioned forms rather than involving Wall
Street.

Now, what about food prices?

Not much evidence of hoarding, as far as I can tell. So this is straightforward supply and demand. Demand may be up to some extent because of that emerging-market boom. But if you look at the FAO reports it becomes clear that the key thing for cereals prices is that production is down in advanced countries, largely owing to terrible weather. And yes, it’s likely that climate change has played a role.

Oh, and what about Ben Bernanke? Well, to the extent that emerging markets are insisting on a fixed exchange rate against the dollar in the face of obvious overvaluation, that contributes to the boom and hence to demand.
But I don’t think it’s reasonable to demand that the Fed stop fighting US unemployment in order to keep Chinese currency manipulation from leading to cotton hoarding by Chinese farmers.

So the story on commodity prices is somewhat different from the story during the last spike. As always, though, it’s crucial to keep your eye on the bale — that is, whatever your logic, it must translate
into actions that affect the physical supply and demand for raw materials.